Question

Payback period.

Given the cash flow of two projectslong dash—A and Blong dash—and using the payback period decision​ model, which​ project(s) do you accept and which​ project(s) do you reject if you have a 3-year cutoff period for recapturing the initial cash​ outflow? For payback period​ calculations, assume that the cash flow is equally distributed over the year.

Cash Flow	A		B
Cost	​ $14,000		​$90,000
Cash flow year 1	​$7,000		​$36,000
Cash flow year 2	​$7,000		​$27,000
Cash flow year 3	​$7,000		​$18,000
Cash flow year 4	​$7,000		​$9,000
Cash flow year 5	​$7,000		​$0
Cash flow year 6	​$7,000		​$0
What is the payback period for project​ A?

Answer 1

Payback period= full years until recovery + unrecovered cost at the start of the year/cash flow during the year

Project A

Payback period= $7,000 + $7,000= $14,000.

The payback period of project A is 2 years.

Project B

Payback period= $36,000 + $27,000 + $18,000 + $9,000= $90,000

The payback period of project B is 4 years.

Since the cut-off period for payback is 3 years, project A should be accepted and project B should be rejected.

In case of any query, kindly comment on the solution.